Competition Makes IT Better

In spite of its potential, the use of digital technology is still basic in most developing countries. This column presents evidence that firms in Mexico facing higher external competition have used IT more intensively and efficiently. External competition has encouraged them to make the necessary complementary investments in innovation and organizational changes.

Digital technology creates opportunities to accelerate growth as firms across the world become more connected. But the 2016 World Bank World Development Report, titled Digital Dividends, showed that the benefits are neither automatic nor assured. Firms’ use of digital technologies differs substantially across countries, and while the internet has reached almost all countries, the use of digital technologies is still basic in most developing countries (Comin and Mestieri 2013). In Mexico, 84 percent of firms with at least ten employees used the internet in 2012, but only 26 percent of employees had internet access, only 13 percent of firms used e-commerce for purchases, and 9 percent for sales. What is preventing developing countries from realizing the benefits of digital technology?

To answer this question, it is important to understand the channels through which IT affects productivity at the firm level. The relation between IT and productivity has been widely studied, but there is still relatively little evidence about these channels. Also, most results have focused on developed countries. Research suggests that firms must pursue complementary investments such as changes in business organization and training, which imply additional costs, to successfully leverage IT investments (Jorgenson et al. 2008). Recent evidence shows that the lack of these complementary investments explains differences in the impact of IT on productivity between the US and advanced European countries (Bloom et al. 2012). But training and business reorganizations are costly, so does increased competition create the incentives to invest in them?

The IT and competition nexus in Mexico

In recent work, we constructed a two-period panel of firm-level information using Mexico’s National Survey on Information Technologies from 2009 and 2013 (Iacovone et al. 2016a). This provides detailed information on IT use and firm performance that, to the best of our knowledge, has not been used for research before.

We analyzed three physical measures of IT use: computers-per-worker, the share of labor with internet, and the share of labor with a computer. The surge of Chinese import competition in the Mexican market was used to measure differences in the degree of competition, using the change in the share of China in total Mexican imports for each sector between 2000 and 2008. We also checked whether more intense Chinese competition for Mexican exporters to the US market led to changes in Mexican firms’ use of IT.

“Our results suggest that competition generated the incentives to use IT more efficiently by promoting not only a more intensive use of IT, but also encouraging the complementary investments in innovation and improvements in an organization.”

We found that firms that faced more intense import competition from China used IT more intensively (Figure 1) and more efficiently (Figure 2). Firms that faced this external shock of higher foreign competition between 2000 and 2008, either in the domestic or the US (export) market, increased the number of computers per employee, the share of labor using the internet, and their share of online purchases in total purchases in the subsequent four years 2008–12. As a result, the number of computers per employee in 2012 was 11 percent higher for firms that faced more Chinese competition, and the share of online purchases was 114 percent higher.

More intensive use of digital technologies for firms selling products that directly compete with imports from China also translated into higher manufacturing productivity growth. For example, firms that increased their share of workers using the internet from zero to one due to high import competition from China had 1.2 percent higher productivity growth between 2008 and 2012. By contrast, ICT use had no impact on labor productivity growth among Mexican firms that did not face import competition from China.

The results are robust when using an instrumental variables approach, relying on subnational and sector-specific information on IT intensity, to account for the endogeneity between firms’ IT use and productivity.

In contrast, we did not find any effects of IT on firm productivity among Mexican firms that did not face more external competition. Our findings are consistent with the hypothesis that competition provides incentives to pursue organizational changes and investment in training associated to IT. We found similar results when we analyzed Chinese competition for these firms in the US market.

The finding that firms in more contested industries use digital technologies more effectively would be consistent with a Schumpeterian mechanism. The allocation and selection mechanism in Mexican or US markets that are more intensively contested by competition from China drives Mexican firms (exporting to the US) to use digital technologies more intensively and productively.

How does competition leverage IT effects on productivity?

We also investigated the connection between competition, firm efficiency in using IT, and complementary investments by using a new set of questions that was included in the last wave of the survey.

We used two scores on innovation that indicated the extent of complementary innovative investments that firms have implemented. The first one recorded innovation activities related to products and processes, such as reductions of training costs, improvements in the design of products, and plant scaling. The second measured organization and marketing innovations, such as access to new markets, better communication within the firm, and implementation of automated systems.

As Figure 3 shows, firms that faced more external competition had better scores in both product and processes innovation, as well as in marketing and organization. In contrast, firms that invested in IT but did not face more external competition pressures did worse in terms of innovation.

Figure 3: Mean innovation score by IT use and competition with China. (a) Products and processes(b) Marketing and organization

We also found that IT use only affected the probability of innovation for firms that competed with Chinese imports. Similarly, the probability of using software for logistics and distribution and control of processes increased with firms’ IT use when only among firms that faced more competition from China. Therefore, our results suggest that competition generated the incentives to use IT more efficiently by promoting not only a more intensive use of IT, but also encouraging the complementary investments in innovation and improvements in an organization.

When does IT boost firm productivity?

We can conclude that the impact of IT use on productivity would be contingent on reforming regulatory barriers. This encourages firms to compete by investing in the efficient use of technology. For instance, subsidizing IT is not enough if barriers to private sector competition through regulation, or insufficient antitrust laws, prevent a level playing field among all firms.

Leonardo Iacovone is a Lead Economist with the Trade and Competitiveness Global Practice at the World Bank. Mariana Pereira-López is a consultant with the Trade Competitiveness Global Practice. Marc Schiffbauer is a Senior Country Economist at the World Bank.

Disclaimer: The ProMarket blog is dedicated to discussing how competition tends to be subverted by special interests. The posts represent the opinions of their writers, not those of the University of Chicago, the Booth School of Business, or its faculty. For more information, please visit ProMarket Blog Policy.